Moody's Sees Good News for Municipalities, Bad News for Hospitals in Tax Ruling

Credit fallout from judge’s opinion in Morristown case depends on whether opinion on nonprofit status is upheld and if Legislature takes action

Morristown Medical Center

Some of New Jersey’s most fiscally challenged cities could look to hospitals as a new source of tax revenue, while some nonprofit hospitals could see a negative effect on their bottom lines as a result of a judge’s recent ruling that most of Morristown Medical Center’s property is not exempt from local taxes.

The bond rating firm Moody’s described the ruling as “credit positive” for Morristown and other municipalities that could turn to their hospitals for property taxes.

On the other hand, Moody’s analysts said the ruling is “credit negative” for New Jersey’s nonprofit hospitals and other not-for-profit organizations in the state if their local municipalities attempt to revoke their property-tax-exempt status.

Judge of the Tax Court Vito Bianco’s ruling could be helpful to the credit ratings of the towns, school districts and counties where nonprofit hospitals are located.

Officials with the New Jersey State League of Municipalities have described it as “a significant victory” for other towns that host hospitals.

They have said that it would be unfair for legislators to change state law if Bianco’s holding is upheld, and that nonprofit and for-profit hospitals should be on an even playing field for property-tax purposes if they continue to operate in a similar manner.

The 10 largest New Jersey hospitals, as measured by the number of beds, are in cities “with varying credit quality and the potential for additional revenue may prove attractive to cities with weaker financial profiles,” according to the Moody’s analysis.

From a hospital-industry perspective, the ruling’s largest effect could be on hospitals that are very different from Morristown Medical Center – facilities that aren’t part of large, financially healthy systems like the Morristown hospital’s parent company, Atlantic Health System.

While the Moody’s analysis found that paying property taxes would harm hospitals’ credit in general, it pointed out that Atlantic Health System’s $2 billion annual revenue base would allow it to sustain the hit from property taxes without hurting its credit rating.

The ratings agency said implications of the ruling could spill beyond New Jersey’s borders if courts reach similar conclusions in other states, affecting hospitals and universities nationally.

Bianco found that Morristown Medical Center’s nonprofit and for-profit activities were so intermingled that most of the hospital was no longer eligible for the property tax exemption under current state law.

The issue of whether hospitals should maintain their exemption has been years in the making, as hospitals have added more and more for-profit subsidiaries. The decision is emblematic of a larger convergence in healthcare between the activities of nonprofit hospitals and their for-profit competitors, according to industry observers.

The exact amount Morristown Medical Center will have to pay Morristown’s municipal government has not yet been determined. The court case focused on 2006 through 2008 -- it’s estimated that the hospital could pay $2.3 million for each of those years. The taxes for the seven years since then remain in dispute.

Hospitals will likely be emphasizing the amount of community benefit they provide to their local areas in making the case for keeping their property tax exemptions. The New Jersey Hospital Association has highlighted these benefits, not only the charity care hospitals provide to uninsured patients, but also the clinics and education programs they present to the public.

The ruling only pertains to local property tax exemptions, and not to federal income tax exemptions for nonprofit hospitals. It comes at a time where hospitals have made a greater effort to emphasize the financial benefits they bring to their communities.

The federal Affordable Care Act imposed new requirements on nonprofit hospitals to create plans to provide community benefits, based on assessments of local needs.

Hospitals’ work on the community health-needs assessments have ranged from minimal efforts that have met the formal requirements of the law to multiyear efforts that have involved extensive surveys, meetings, and collaborations with area residents and community groups.

Healthcare consultant Matthew D’Oria said the Moody’s analysis highlights a dilemma for municipalities that may be tempted to pursue property taxes from hospitals -- while they may want the revenue, they also want to continue to benefit from their local hospitals and the community services they provide.

In the case of city hospitals that aren’t part of larger systems, having to pay property taxes could affect their ability to maintain services, said D’Oria, a former deputy commissioner of the state Department of Health.

He also noted that large health systems receive much of their revenue from subsidiaries in different municipalities than where their hospital buildings are located, which could complicate tax-exemption cases.

For example, some hospital systems that have their historical roots in cities have purchased medical practices, ambulatory surgery centers, and other for-profit revenue centers in nearby towns. So their for-profit activities may be largely concentrated outside of the cities where their central buildings are located.

In the Morristown case, hospital officials argued that the organization follows long-established and universal practices by hosting services offered by both doctors employed by the hospital and self-employed physicians who operate for-profit businesses.

But Bianco, in examining the history of hospitals, found that they had strayed from the strictly charitable function they served when the state originally granted them exemptions.

For example, he cited a scholarly article that said the first American hospitals were founded as charities to serve “the diseased poor and the mentally ill,” with all of their revenue coming from charitable donations.

He also noted a U.S. Supreme Court decision that tied hospitals’ status as charities to the services they provide to the poor, and 1913 and 1918 state laws that tied hospitals’ tax exemption to the exclusive use of their buildings for charitable purposes.

But leading Democratic legislator says state could restore tax exemption if judge’s opinion stands

Bianco also found that Morristown Medical Center failed to prove that its executives’ compensation wasn’t excessive. Former CEO Joseph Trunfio received $12.5 million over the three years at issue in the case.

Morristown Medical Center officials have said they are weighing their options, while legal observers expect an appeal. Even if the ruling is upheld, the Legislature could act to ensure that nonprofit hospitals maintain their exemption, which is what happened when a similar ruling occurred in Illinois

New Jersey Hospital Association CEO Betsy Ryan said the ruling adds uncertainty to hospitals’ outlook. She said the Moody’s analysis “echoes one of our greatest concerns, that the impact of the ruling will have negative consequences on other nonprofit hospitals and perhaps even other nonprofit entities. I could imagine entities like higher education, other health providers such as nursing homes, maybe churches that run schools or daycare centers – all of them watching this unfold with a lot of concern.”